Commentary: Helping ordinary investors navigate treacherous markets

HowardGold

NEW YORK (MarketWatch) — Last week came the sad news that Martin Zweig had died at the absurdly young age of 70.

Many tributes to him (which included an insightful commentary by Mark Hulbert in MarketWatch) recalled his memorable appearance on Wall Street Week with Louis Rukeyser on Fri., Oct. 16, 1987 where he warned of a stock market crash. It happened the following Monday, and Zweig’s reputation as a forecaster was sealed.

Still, that understates his importance. A numbers wizard (he got a PhD in finance from Michigan State), Zweig saw patterns in the market no one else could. His newsletter, The Zweig Forecast, had a stellar track record, according to Hulbert, and he ran a successful hedge fund with his business partner Joseph DiMenna. Zweig, who famously purchased a multistory penthouse apartment in New York City’s Pierre Hotel for a record $21.5 million in 1999, had a net worth estimated in the hundreds of millions of dollars.

But he also had a simple philosophy that can help ordinary people navigate even the most treacherous markets. By sticking to it, investors can participate in the upside while limiting downside risk. Many people claim to have done that, but Zweig actually did.

I interviewed him back in the late 1980s as a much-younger reporter at a small, feisty business paper in Miami, where he spent some of his formative years. He didn’t give many interviews (and none I could find recently), but he was gracious and his passion for investing was evident. I recently re-read his first book, “Winning on Wall Street,” originally published in 1986. The many statistics are dated, but the insights are timeless.

Zweig’s nostrums are well known — “Don’t fight the Fed,” “don’t fight the tape” — but they shouldn’t be taken for granted. Used correctly, they’re a recipe for making money and reducing risk.

‘Don’t fight the Fed’

“Monetary conditions exert an enormous influence on stock prices,” he wrote in “Winning on Wall Street.”

“Indeed, the monetary climate—primarily the trend in interest rates and Federal Reserve policy—is the dominant factor in determining the stock market’s major direction.”

“Generally a rising trend in rates is bearish for stocks; a falling trend is bullish,” he continued.

Why? For two reasons. “First, falling interest rates reduce the competition on stocks from other investments, especially short-term instruments such as Treasury bills, certificates of deposit, or money market funds,” he wrote.

“Second, when interest rates fall, it costs corporations less to borrow. As expenses fall, profits rise…So, as interest rates drop, investors tend to bid prices higher, partly on the expectation of better earnings.”

Isn’t that exactly what’s happened now? After resisting for years while the Fed drove real short-term interest rates below zero, investors have jumped back into US stock mutual funds and ETFs.

And companies have zealously controlled their expenses and have refinanced every bit of debt they could at rock-bottom rates. No wonder corporate profits are at their highest percentage of GDP in more than 60 years.

‘Don’t fight the tape’

“Big money is made in the stock market by being on the right side of the major moves,” he wrote. “The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not…Strong momentum tends to persist…Fighting the tape is an open invitation to disaster.”

Zweig advised investors not to go all in or out, but to keep a position in stocks and increase it when the risk was low while reducing it when the risk was high. “What you are concerned with is the probability of success or, alternatively, the probability of losing money. You want to avoid loss. So, it’s fine to buy above the bottom and to sell below the top,” he wrote.

How do we know if we’re near a top? Start with the Fed, of course. When rates are low, as they are now, the second of two rate hikes or a one-percentage-point increase in the prime rate would trigger a Zweig sell signal.

Would the end of “quantitative easing” constitute a rate hike? Good question, but I doubt it. That means we probably don’t have to worry about a monetary sell signal until at least 2014.

Zweig found that every bear market from 1919 to 1982 had at least one of three conditions: extreme deflation; “ultrahigh” price/earnings ratios in the upper teens and twenties, or an inverted yield curve, where short-term interest rates exceed long-term rates.

Seen any of those lately? Not in this galaxy.

We live in confusing times — slow economic growth, the aftermath of a major financial crisis, ballooning national debt and the loosest monetary policy the Fed has ever pursued. But that loose policy has staved off deflation and the inverted yield curve that often precedes recessions — two of Zweig’s critical indicators for bear markets.

Far too many investors have been paralyzed by fear during the current four-year bull market, while the key signs that Zweig and others (like Jim Stack) look at have been persistently bullish.

And too many people have stayed away because they were afraid of fiscal cliffs or sequesters or Europe or were philosophically opposed to the Fed’s easy money policy.

That’s fine — I don’t like the Fed’s policy, either. But when the Federal Reserve — in Zweig’s words, “the dominant factor in determining the market’s major direction” — is giving away stock market profits, do you really want to sit on the sidelines out of principle? That’s crazy.

Marty Zweig believed that flexibility was the most important trait of successful investors — their ability to apply core precepts to fluid markets and change their minds when conditions warranted. It’s a shame this great thinker is no longer with us, but he left a roadmap of how it can be done, if only we focused on the right things.

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